People are generally comfortable and feel secure when their lives are stable, predictable and filled with certainty. This year will be remembered for all of the drastic changes.
We have endured a pandemic, a stock market crash and the election of a new president, all in a matter of eight months. Our world has been unpredictable, uncertain and unstable. To sum up 2020, it has been a year of change.
Fortunately, as we are approaching the end of this year, the stock market has rebounded from its historical lows, COVID-19 vaccines are on the horizon and elections are now over.
As we enter 2021, many unknowns will still exist. We do not know the long-term ramifications of COVID-19 on our economy or how quickly the logistically challenged vaccines will be administered to 7.8 billion people around the world.
What we can anticipate is that new tax legislation will be proposed under President-Elect Joe Biden’s incoming administration. Biden’s current plans include many changes to our current payroll tax, individual income tax and estate and gift tax laws. According to taxfoundation.org, we should be prepared for the following:
A 12.4% Social Security payroll tax for wages above $400,000. This would create a “doughnut hole” in the current Social Security payroll tax, where wages between $137,700, the current wage cap, and $400,000 are not taxed. However, for earned income above $400,000, the 12.4% payroll tax would be reinstated. The Motley Fool estimates this would raise between $797 billion and $1.04 trillion over the next decade.
The top individual income tax rate for taxable incomes above $400,000 will revert to the pre-Tax Cuts and Jobs Act level of 39.6% from 37% under current law. For the 2020 tax year, this top marginal rate is applied to earned income above $518,400 for single filers and more than $622,050 for married couples filing jointly.
Long-term capital gains tax and qualified dividends will increase to the ordinary income tax rate of 39.6% on income above $1 million, as well as eliminating the step-up in basis for capital gains taxation.
Expect the restoration of the Pease Limitation on itemized deductions for taxable incomes above $400,000. Under the Pease Limitation, the itemized deductions for the high-income taxpayer are reduced by the lesser of 3% of adjusted gross income above a specified income threshold or 80% of the filer’s allowable itemized deductions.
A limit of 28% on itemized deductions. For each dollar of itemized tax deductions, including charitable contributions, a taxpayer or couple filing jointly would only receive a maximum benefit of $0.28. This 28% limit would hold true even if a filer is paying a higher marginal tax rate.
Phasing out of the qualified business income deduction (Section 199A) for filers with taxable income above $400,000. As the law stands now, the qualified passthrough business deduction allows small business owners to deduct up to 20% of their business income under the TCJA, capped at $163,300 for single filers and $326,600 for joint filers in 2020.
However, for individuals and couples earning above these thresholds, an abundance of rules exist that determine whether or not you’re allowed to take qualified business income deductions. Biden’s plan aims to simplify this by keeping QBI deductions in place for those with less than $400,000 in earnings but phasing out passthrough deductions for those with more than $400,000 in earnings.
Expansion of the earned income tax credit for childless workers age 65 and over and providing renewable-energy-related tax credits to individuals.
In 2021, if economic conditions require, the child tax credit could increase from a maximum value of $2,000 to $3,000 for children 17 or younger, while providing a $600 bonus credit for children under 6. The CTC would also be made fully refundable, removing the $2,500 reimbursement threshold and 15% phase-in rate.
Expansion of the child and dependent care tax credit from a maximum of $3,000 in qualified expenses to $8,000 ($16,000 for multiple dependents) and increases the maximum reimbursement rate from 35% to 50%.
Reintroduction of the first-time homebuyers’ tax credit, which was originally created during the Great Recession to help the housing market. Biden’s homebuyers’ credit would provide up to $15,000 for first-time homebuyers.
Equalization of the tax benefits of traditional retirement accounts such as 401(k)s and individual retirement accounts by providing a refundable tax credit in place of traditional deductibility.
Expansion of the estate and gift tax by reducing the estate tax exemption amount to $3.5 million from the 2020 limit of $11.58 million and increasing the top rate for estate tax from 40% to 45%.
Limitations on the step-up in basis rules. A step-up in basis refers to the cost basis of assets or property transferrable to an heir upon death. If an individual purchased a home for $300,000 but it was worth $600,000 at the time of death, the heir would pay capital gains on anything over $600,000 when the home was sold. If Biden’s proposal were to become law, heirs would pay capital gains on anything over $300,000.
Repeal the limit restricting deduction of state and local taxes to $10,000.
According to the Tax Foundation General Equilibrium Model, Biden’s proposal in its entirety would raise $1.553 trillion from 2020 to 2029. Eventually, this tax plan would reduce the economy’s size by 1.62%. The plan would shrink the capital stock by about 3.75% and reduce the overall wage rate by a little over 1%, leading to about 542,000 fewer full-time equivalent jobs.
It is important to note that if the Democrats hold a majority in the House and the Republicans hold a majority in the Senate, any new tax legislation is likely to require compromise by both parties, limiting the scope of what would be implemented.
We do not know what will happen next year. But we can use the knowledge that we have today to make positive decisions regarding our future. If the proposals under President-elect Biden’s administration could have detrimental effects for you, schedule a meeting with your estate planning attorney, tax advisor, or financial adviser.
While we are not able to predict with certainty stability in our lives, we do have a small window of opportunity left this year to take advantage of effective tax and estate planning techniques. A change that we can control.
Teri Parker CFP® is a vice president for CAPTRUST Financial Advisors. She has practiced in the field of financial planning and investment management since 2000. Reach her via email at [email protected].